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LIBRARY 

OF  THE 

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PAPERS 


OUR   DEFECTIVE 

AMERICAN   BANKING 

SYSTEM 

FREDERICK  WILLIAM  GOOKIN 


CHICAGO 
LITERARY 
LUB 


OUR  DEFECTIVE 
AMERICAN  BANKING  SYSTEM 


Our  Defective 
American  Banking  System 

A  Diagnosis  and  a 
Prescription 

By 
Frederick  William  Gookin 


Chicago   Literary  Club 
1909 

I  UNIVERSITY   I 


' 

COPYRIGHT,  1909 
FREDERICK  WILLIAM   GOOKIN 


//  OF   THE  NX 

UNIVERSITY  J 


OUR    DEFECTIVE  AMERICAN 
BANKING   SYSTEM 

HE  periodic  recurrence  in 
the  United  States  of  se- 
vere financial  crises,  from 
which  the  other  great  na- 
tions of  the  world  are  near- 
ly if  not  quite  exempt,  in- 
dicates that  something  is 
fundamentally  wrong  with 
our  banking  system  and  credit  machinery. 
It  is,  indeed,  not  uncommon  to  hear  that 
system  denounced  as  the  worst  now  to  be 
found  in  any  civilized  land.  To  this  ex- 
tent has  a  glimmering  of  the  truth  begun 
to  penetrate  our  minds.  A  few  of  us 
are  beginning  to  sit  up  and  rub  our  eyes, 
and  to  ask  whether  it  is  creditable  to  our 
prescience  as  a  nation,  or  to  the  acumen  of 
our  men  of  affairs,  that  such  an  incubus 
upon  our  prosperity  should  be  allowed  to 
continue. 


191678 


This  much  fruit  has  come  of  the  ups  and 
downs  of  the  last  sixteen  years,  and  of  the 
active  discussion  of  economic  principles  and 
banking  science  to  which  they  have  given 
rise.  The  nature  of  the  disease  from  which 
we  suffer  may  now  be  said  to  be  fairly  well 
understood.  The  amazing  thing  in  con- 
nection therewith  is  the  widespread  inabil- 
ity to  perceive  what  must  be  the  remedy 
if  a  remedy  is  ever  to  be  applied.  In  large 
measure  this  inability  is  due  to  deliberate 
shutting  of  the  eyes.  But  truth  is  not  the 
less  vital  because  we  are  reluctant  to  rec- 
ognize it.  As  the  old  adage  puts  it, 
' '  There  are  none  so  blind  as  those  who 
will  not  see."  The  bankers,  in  particular, 
are  resolute  in  their  averted  gaze.  Their 
attitude  may  be  likened  to  that  of  men 
afloat  in  badly  designed  and  leaky  craft 
that  in  stormy  weather  can  be  kept  above 
water  only  with  the  utmost  difficulty,  yet 
who  are  unwilling  to  consider,  even  for  a 
moment,  anything  more  efficacious  than 
some  novel  pump,  and  who  repel  with  hor- 
ror the  idea  of  closing  the  seams,  or  of  trans- 
ferring their  persons  and  property  to 
staunch  and  seaworthy  vessels  of  approved 
construction. 

To  some  extent,  it  must  be  admitted,  the 
hostility  of  the  bankers  comes  from  unwill- 
ingness to  be  thought  unpractical  through 
advocacy  of  measures  which  they  believe 
8 


have  no  chance  of  adoption,  since  legisla- 
tors are  too  ignorant  of  the  intricacies 
of  finance  to  venture  upon  a  complete 
overturning  of  the  present  system,  and 
managers  and  owners  of  existing  banking 
institutions  may  be  counted  upon  to  oppose 
with  all  their  might  any  enactment  likely  to 
have  that  effect.  And  so,  while  continu- 
ally complaining  of  the  ills  that  need  cor- 
recting, they  are  unable  to  propose  any 
effective  plan  for  doing  away  with  them. 
If  only  some  one  could  devise  a  reformation 
that  would  leave  things  as  they  are  !  That 
apparently  is  what  many  desire.  They 
might  with  as  much  reason  expect  the  art 
of  swimming  to  be  acquired  without  ven- 
turing into  the  water. 

What,  then,  should  be  done  ?  Is  it  such 
a  simple  matter?  Have  not  many  of  our 
most  experienced  financiers  puzzled  their 
heads  over  it  for  years  without  reaching  any 
conclusion  ?  Are  they  not  wise  in  hesitat- 
ing to  recommend  innovations  the  conse- 
quences of  which  cannot  possibly  be  fore- 
seen ? 

The  last  of  these  questions  may  be  an- 
swered first.  The  placing  of  our  banking 
and  financial  system  upon  a  thoroughly 
scientific  and  eminently  sound  basis  involves 
no  experiment  whatever.  There  is  not  the 
slightest  need  of  trying  anything  that  has 
not  been  tried  over  and  over  again,  that  is 


not  subject  to  the  test  of  e very-day  use  in 
other  countries  of  the  first  rank. 

Before  answering  the  question,  "What 
should  be  done?"  it  will  be  well  to  glance 
at  certain  things  in  the  situation  with  which 
we  have  to  deal. 

There  are  in  the  United  States  about 
21,400  banking  institutions,  national,  state, 
and  private.  Theoretically,  each  of  these 
stands  upon  its  own  feet,  so  to  speak;  prac- 
tically, all  are  made  mutually  dependent 
upon  each  other  by  the  practice  of  deposit- 
ing and  redepositing  a  large  part  of  their 
reserves  with  one  another.  By  this  prac- 
tice, which  is  an  outgrowth  of  the  necessity 
of  carrying  balances  for  exchange  purposes, 
all  are  tied  together  in  a  complex  credit 
structure  inherently  weak  and  certain  to 
break  down  under  any  unusual  strain.  The 
consequences  of  this  practice  are  most  per- 
nicious. Virtually  it  amounts  to  a  pooling 
of  the  reserves,  and  to  the  making  of  the 
banks  in  the  city  of  New  York  the  final 
reserve  agents  for  the  banks  of  the  entire 
country.  And  as  these  reserve  agents  do 
not  set  the  reserve  funds  apart  and  hold 
them  in  cash  as  "special  deposits,"  but 
merge  them  with  their  other  deposits  and 
pay  interest  upon  them,  they  must  lend  as 
nearly  as  possible  seventy-five  per  cent 
of  the  total  to  make  the  transaction  profit- 
able. Thus  it  will  be  seen,  when  a  crisis 
10 


arrives,  the  actual  reserves  of  the  banks  of 
the  interior  consist  of  little  more  than  the 
cash  in  their  own  vaults;  for,  while  their 
balances  in  the  hands  of  reserve  agents  are 
ordinarily  available,  they  become  unavail- 
able in  time  of  stress,  as  any  general  demand 
for  currency  to  the  extent  of  twenty-five 
per  cent  of  the  total  of  such  balances 
would  exhaust  the  entire  amount  of  cash 
held  against  them  by  the  New  York  banks. 
Experience  shows  that,  as  was  the  case  in 
October,  1907,  a  demand  for  much  less  than 
this  percentage  may  force  suspension  of 
cash  payments,  not  only  by  the  New  York 
banks,  but  by  those  in  the  other  so-called 
' '  central  reserve  cities. ' '  Nor,  when  a 
pinch  comes,  can  the  banks  in  the  interior 
avoid  making  such  demand.  Usually  it  is 
accompanied  by  urgent  requests  for  redis- 
counts, one  inevitable  consequence  of  the 
practice  of  redepositing  reserves  being  that 
banks  everywhere  throughout  the  country, 
except  those  in  the  city  of  New  York,  which 
have  nowhere  to  turn  unless  it  be  to 
Europe,  are  tempted  to  lean  upon  some 
other  bank's  credit  to  save  their  own.  Just 
before  the  panic  of  1907,  6,178  national 
banks  not  located  in  "reserve  cities"  show- 
ed balances  aggregating  $420,000,000  due 
to  them  from  reserve  agents  in  those 
cities,  but  only  about  $201,000,000  cash  in 
their  own  vaults.  That  they  could  not 
ii 


avoid  calling  upon  these  reserves  plainly 
appears  from  their  published  statements 
as  of  December  3,  1907,  which  show  that 
they  did  not  withdraw,  or,  to  put  it  blunt- 
ly, were  unable  to  withdraw  from  their 
reserve  agents  as  much  as  was  withdrawn 
from  them  by  their  own  depositors. 

As  the  balances  due  to  other  banks  form 
only  about  forty  per  cent  of  the  total  de- 
posit liabilities  of  the  New  York  banks,  it 
may  be  wondered  why  the  withdrawal  of  a 
moderate  portion  of  these  balances  should 
have  such  far-reaching  effects.  Ordinarily 
it  does  no  more  than  form  one  of  the  con- 
tributory causes  that  bring  about  the  recur- 
rent stringency  in  the  "money  market " 
that  is  experienced  every  autumn.  But 
when  it  is  the  result  of  disturbed  confidence 
in  the  financial  equilibrium,  the  normal  ef- 
fect of  the  pressure  for  liquidation  that  it 
produces  is  greatly  intensified,  with  result- 
ant marked  increase  in  the  stringency,  and 
heightened  alarm  which  may  easily  reach 
the  proportions  of  panic.  In  considering 
these  things,  it  should  constantly  be  borne 
in  mind  that  any  pressure  upon  the  banks 
is  instantly  and  of  necessity  transferred  to 
the  business  community  as  a  whole,  usually 
with  the  effect  of  increasing  the  pressure 
upon  the  banks  and  in  turn  upon  the  com- 
munity, in  a  vicious  circle, — a  movement 
which,  when  once  fairly  started,  can  only  be 

12 


checked  by  general  liquidation  and  very 
considerable  curtailment  in  the  volume  of 
commercial  transactions. 

It  should  also  be  borne  in  mind  that  in 
the  modern  financial  fabric  the  principal 
function  of  money — actual  cash  that  is, 
which  should  be  clearly  distinguished  from 
loanable  capital  in  the  form  o)  credit — is  to 
furnish  the  basis  for  credit,  and,  through  the  \ 
medium  of  the  banks,  to  make  money,  cap- 
ital, and  credit  to  a  large  extent  convertible 
terms.  The  loaning  power  of  the  banks, 
therefore,  is  closely  related  to  the  percent- 
age which  the  actual  cash  on  hand  bears  to 
their  deposit  liabilities,  all  credits  in  open 
account  being  in  American  parlance  spoken 
of  as  "deposits/'  Thus  it  comes  about 
that  when  the  banks  in  the  interior  send 
their  surplus  funds  to  their  correspondents 
in  New  York,  so  that  these  funds  may  earn 
a  little  interest  during  the  dull  season  of 
the  year,  when,  for  lack  of  borrowers,  they 
cannot  be  employed  at  home,  the  loaning 
power  of  the  New  York  banks  is,  in  the 
aggregate,  increased  not  merely  by  the 
amount  of  such  cash,  but  by  nearly  four 
times  that  amount.  This  would  not  be 
true  were  the  New  York  banks  to  lend  to 
foreign  borrowers  who  would  call  for  the 
cash  and  take  it  away ;  but  it  is  true  to  the 
extent  that  loans  are  represented  by  cred- 
its upon  the  books  of  the  banks,  which, 

13 


when  withdrawn  by  check,  are  redeposited 
to  the  credit  of  other  customers.  What- 
ever the  experience  of  any  individual  bank, 
the  result  for  all  is  a  considerable  increase 
in  both  loans  and  deposits. 

Now,  as  the  New  York  banks  have  estab- 
lished the  custom  of  paying  interest  upon 
balances  of  other  banks  at  a  rate  fixed  for 
the  entire  year  and  not  governed  by  market 
conditions  as  is  customary  in  other  coun- 
tries, they  must  find  employment  for  nearly 
all  of  their  loanable  funds  if  they  are  to 
avoid  loss.  And  in  forcing  these  funds 
into  use  at  the  dull  season  of  the  year,  the 
inevitable  consequence  is  that  the  funds 
find  their  way  into  the  hands  of  speculators. 
This  is  true  of  the  other  reserve  cities  as 
well  as  of  New  York,  the  difference  being 
chiefly  one  of  degree.  Thus  it  is  that  our 
banking  system  becomes  a  colossal  machine 
for  fostering  speculation;  a  machine  in  which 
each  bank  is  carried  along  by  the  general 
current,  without  power  successfully  to  resist 
its  sweep  or  to  avert  its  consequences. 

The  banks  have  been  severely  criticised 
for  their  part  in  this  procedure.  It  has 
been  justly  stigmatized  as  a  disgrace  to  a 
civilized  community,  and  to  the  banking 
fraternity  in  particular,  that  so  large  a  part 
of  the  free  loanable  capital  upon  which  the 
commerce  of  the  country  is  dependent 
should  be  locked  up  in  stock  exchange  or 

U 


other  speculations,  thus  fostering  periodic 
crises,  with  their  attendant  trail  of  paralyzed 
industries,  wide-spread  disaster,  and  misery. 
Let  us,  however,  be  fair  to  the  managers 
of  the  banks.  As  certainly  as  the  sum- 
mers come  around  does  more  or  less  of 
this  loanable  capital,  temporarily  freed  from 
use,  accumulate  upon  their  hands.  With 
rare  exceptions,  here  and  there,  they  pay 
interest  upon  it,  unwillingly  in  the  case  of 
very  many  of  them,  but  nevertheless  of 
necessity,  because  their  competitors  do  so. 
The  country  bankers,  having  no  use  at 
home  for  their  accumulations,  desiring  to 
earn  even  a  little  interest  upon  them,  and 
fearing  to  take  the  risk  of  robbery  if  they 
carry  unusual  sums  in  their  vaults,  send 
them  to  the  cities.  The  banks  in  the  small- 
er cities,  being  similarly  situated  as  regards 
the  plethora  of  loanable  funds,  pass  their 
surplus  along  to  the  banks  in  the  larger 
cities ;  and  they  in  turn  deposit  theirs  with 
the  banks  in  New  York. 

What,  then,  should  the  metropolitan 
bankers  do  under  the  circumstances?  Re- 
fuse to  take  this  capital  on  deposit  and  pay 
interest  upon  it  ?  That  would  be  the  sane 
and  prudent  course,  but  it  is  a  course  they 
dare  not  take.  Self-interest  interposes. 
The  few  who  perceive  the  danger  are  help- 
less in  the  face  of  the  established  custom : 
should  they  turn  away  deposits  for  which 

15 


their  rivals  clamor,  they  would  merely  in- 
jure their  own  business  without  relieving 
the  general  situation.  As  a  matter  of  fact, 
there  is  but  one  thing  they  can  do  if  they 
are  to  continue  in  business,  and  that  is  to 
take  the  money  and  lend  it  as  best  they 
can.  This  means  that  the  capital — de- 
posits, or  credit  balances  in  the  language 
of  the  banks,  or  '  '  money ' '  as  it  is  styled 
in  the  jargon  of  the  street — must  be  forced 
into  use  regardless  of  the  difficulty,  if  not 
the  impossibility,  of  withdrawing  it  when 
needed  for  the  active  commerce  of  the  au- 
tumn and  winter.  If,  in  the  effort  to  find 
safe  employment  for  the  funds  thus  com- 
mitted to  their  charge,  the  bankers  play  into 
the  hands  of  the  millionaire  speculators, 
they  are  not  so  culpable  as  may  seem  when 
viewed  from  without.  These  speculators 
are  among  the  very  best  customers  of  the 
banks;  they  carry  the  largest  balances 
without  interest;  they  offer  what  is  under 
ordinary  circumstances  the  most  readily 
marketable  security;  they  control,  directly 
or  indirectly,  many  of  the  sources  from 
which  the  banks  derive  profitable  business. 
Moreover,  the  purpose  for  which  loans 
upon  collateral  are  negotiated  is  not,  as 
a  rule,  known  to  the  lenders.  Even  the 
personality  of  the  borrowers  is  frequently 
hidden,  the  loans  being  negotiated  through 
brokers.  Nor  is  this  all:  much  of  the 
16 


borrowing  is  from  individuals,  insurance 
companies,  trust  companies,  and  to  some 
extent  from  country  banks  direct.  But 
whoever  the  lenders,  when  the  autumnal 
activity  arrives  the  pressure  bears  with 
most  severity  upon  the  New  York  banks, 
where  the  credit  balances  are  carried. 

From  their  intimate  relation  to  the 
financial  transactions  that  pass  through 
their  hands,  the  bankers  cannot  plead 
ignorance  of  what  is  going  on  in  the  field 
either  of  legitimate  business  or  of  specu- 
lation. But  individually  they  are  not  free 
agents ;  the  working  of  the  system  is  more 
powerful  than  they  are.  Collectively  they 
do  not  act;  the  number  of  independent 
rival  institutions  precludes  concerted  action 
except  in  great  emergencies,  whether  for 
their  own  protection  or  that  of  the  general 
public. 

The  truth  is,  that  our  present  system  — 
if  system  it  can  properly  be  called  — con- 
sisting of  several  different  kinds  of  banking 
institutions,  all  engaged  in  more  or  less 
cutthroat  competition,  all  pushing  each 
other  into  unsound  practices,  but  pulling 
apart  and  forcing  disaster  when  a  crisis 
becomes  imminent,  and  only  uniting  to 
a  limited  extent  for  mutual  protection 
through  the  medium  of  the  Clearing  House 
Associations  when,  to  use  a  convenient 
metaphor,  they  have  pulled  the  house 

17 


down  upon  their  heads,  is  fundamentally 
and  incurably  weak.  The  weakness  is  an 
inseparable  concomitant  of  the  large  number 
of  separate  units.  Nominally  independent, 
the  relations  they  sustain  to  each  other 
and  to  the  community  make  actual  inde- 
pendence impossible. 

In  itself,  it  is  well  to  note,  speculation 
is  not  necessarily  harmful  to  the  common 
weal.  There  is  no  hard-and-fast  line  of 
demarcation  between  it  and  so-called  legiti- 
mate business.  As  a  matter  of  fact,  both 
merge  imperceptibly  into  one  another.  To 
an  extent  much  greater  than  is  commonly 
realized,  speculation  is  a  steadying  force 
so  far  as  prices  are  concerned.  The  pro- 
fessional speculators,  sometimes  known  as 
market  gamblers,  are,  more  especially  the 
larger  operators,  a  remarkably  astute  set 
of  men.  In  general,  they  merely  antici- 
pate normal  price  movements  and  stand  to 
win  only  when  they  guess  right,  though  of 
course  their  dealings  may  at  times  bring 
about  artificial  conditions  with  results  some- 
times profitable  and  sometimes  disastrous. 
The  real  service  of  speculation  comes 
through  making  a  wide  and  quick  market 
for  staple  food  supplies,  bonds,  and  the 
shares  of  joint-stock  corporations.  With- 
out speculation  the  function  of  the  stock 
exchanges  would  be  far  less  effectively 
performed ;  listless  markets  and  wide  fluc- 
18 


tuations  in  prices  would  almost  certainly 
be  the  rule,  and  not  the  exception. 

But  it  is  just  here  that  the  harm  arises, 
and  in  connection  with  our  banking  system 
the  injury  that  results  is  of  stupendous 
magnitude.  Because  of  the  quick  market 
for  '  *  securities , ' '  as  stocks  and  bonds  are 
dubbed  in  the  language  of  "the  street,  " 
they  have  come  to  be  regarded  as  the  most 
desirable  basis  for  loans  by  the  banks. 
Nevertheless,  they  represent  fixed  capital, 
the  fluidity  being  only  apparent  and  dis- 
appearing when  most  desired.  And  it  is 
not  sound  banking  for  institutions  whose 
deposit  liabilities  are  payable  on  demand  to 
invest  a  preponderate  percentage  of  their 
assets  in  loans  upon  securities  representing 
fixed  capital.  Yet  that  is  just  what  the 
banks  and  trust  companies  in  New  York  and 
the  larger  Eastern  cities  commonly  do.  Mr. 
Charles  A.  Conant  puts  the  truth  tersely 
in  a  significant  sentence,  when  he  asserts 
that  "there  is  hardly  a  greater  menace  to 
the  security  of  the  New  York  money  mar- 
ket than  the  vaunted  fact  that  it  is  the 
only  strictly  'call  money  market'  in  the 
world."1 

While  this  is  true,  nevertheless  it  is  not 
so  much  the  aggregate  sums  employed  in 
open  market  speculation  or  in  attempted 

1 "  The  Regulation  of  the  Stock  Exchange, "  Atlan- 
tic Monthly,  September,  1908. 

19 


market  manipulation,  nor  yet  the  failure 
of  speculative  enterprises  to  bear  fruit  as 
quickly  as  the  speculators  expect,  as  it  is 
the  financing  of  new  issues  of  stocks  and 
bonds  that  tie  up  the  floating  capital  and 
put  it  into  fixed  form.  When  "  money 
is  cheap, "  or,  to  put  it  more  accurately, 
when,  because  of  the  accumulation  in  the 
financial  centers  of  a  large  part  of  the  free 
loanable  capital  of  the  country,  rates  of  in- 
terest are  low,1  is  naturally  the  time  most 
often  selected  for  marketing  large ' '  blocks ' ' 
of  new  securities.  The  form  of  such 
undertakings  varies;  but  commonly  the 
new  issues  are  underwritten  by  syndicates 
of  dealers  who  furnish  the  capital  and 
recoup  themselves  as  the  securities  are 
absorbed  by  the  investing  public.  When 
the  public  is  slow  to  purchase,  and  the 
securities  have  to  be  carried  by  the  syndi- 
cates, they  are  said  to  be  "  undigested. M 
Whether  the  members  of  the  syndicates 
advance  the  capital  from  their  own  coffers 
or  borrow  it  from  the  banks  or  other 
lenders  makes  no  difference  so  far  as  the 
effect  upon  the  loan  market  is  concerned. 
There  has  been  a  conversion  of  fluid  capi- 
tal into  fixed  capital.  Such  conversion  is 
going  on  all  the  time,  and  so  long  as  in  the 

1  Not  infrequently  the  current  "  call  money  "  rate  in 
New  York  is  lower  than  the  rate  allowed  by  the  met- 
ropolitan banks  upon  balances  of  other  banks. 

20 


aggregate  it  does  not  exceed  the  produc- 
tion of  fluid  capital,  no  harm  ensues.  But 
when  the  annual  increment  of  fresh  capital 
is  exceeded,  a  condition  supervenes  that  is 
necessarily  fraught  with  grave  peril  to  the 
country.  Inevitably,  under  our  system, 
the  current  loanable  funds  of  the  banks 
which  form  the  final  reserve  against  their 
deposit  liabilities  are  either  directly  or  indi- 
rectly drawn  upon  and  made  unavailable  to 
liquidate  these  liabilities.  ' '  The  individual 
institution, ' '  as  Mr.  Conant  aptly  expresses 
the  situation,  "may  protect  itself  by  the 
drastic  sacrifice  of  securities  when  it  needs 
cash,  but  it  does  so  only  at  the  expense  of 
its  clients,  and  with  a  disturbance  to  the 
money  market  and  the  market  for  securities 
which  is  abnormal  and  excessive/'  If  the 
losses  made  inevitable  by  such  forced  liqui- 
dation fell  only  upon  those  who,  by  abstract- 
ing from  the  market  the  supply  of  free 
loanable  capital  that  is  its  life-blood,  were 
chiefly  instrumental  in  causing  them,  the 
consequences  would  be  bad  enough.  They 
are  intensified  many  fold  when,  as  inevi- 
tably happens,  they  fall  alike  upon  "the 
just  and  the  unjust, "  and  an  embargo  is 
placed  upon  the  general  business  of  the 
country,  making  property  of  almost  all 
kinds  less  marketable,  values  uncertain, 
and  ventures  of  any  sort  ultra-hazardous. 
The  poor  borrower,  who  finds  himself 
21 


caught,  and  either  forced  to  pay  an  extraor- 
dinarily high  rate  of  interest  or  is  "sold 
out/'  has,  in  most  instances,  committed 
no  crime,  economic  or  other,  for  which  he 
should  be  so  severely  punished.  The  bank- 
er, on  his  part,  may  also  hold  himself  blame- 
less ;  and  indeed,  as  has  been  shown,  he  is 
largely  a  mere  cat's-paw,  powerless  in  the 
grip  of  a  bad  system.  Nevertheless,  the 
bankers  of  the  country  cannot  blink  their 
obligation  to  take  a  broader  and  more  intelli- 
gent view  of  their  duty  to  the  people  as  a 
whole.  The  prevalent  notion,  that  all  a 
banker  is  called  upon  to  do  is  safely  to 
lend  the  funds  in  his  care  and  to  pay  his 
depositors'  drafts  upon  demand,  is  unten- 
able. Most  causes  in  this  world  have  dual 
effects — direct  and  reflex — and  the  man 
of  affairs  is  as  truly  bound  to  consider  the 
one  as  the  other. 

To  eradicate  the  weakness  in  our  bank- 
ing system  the  cause  must  be  removed. 
The  regeneration  must  be  radical  and  com- 
prehensive. Real  reformation  will  never 
come  from  anything  else.  No  half-way 
measures  will  suffice.  The  sooner  this  is 
comprehended  the  better  will  it  be  for  all 
concerned.  None  of  the  remedies  that 
have  been  proposed  touch  the  root  of  the 
difficulty;  most  of  them  would  be  more 
likely  to  aggravate  the  trouble  than  to 
ameliorate  it.  Of  this  nature  is  the  prop- 
22 


osition  that  the  banks  should  be  permitted 
to  issue  "emergency  circulation/'  based 
upon  bonds  as  security.  It  should  be  ob- 
vious upon  very  little  reflection  that  if  such 
circulation  is  not  put  out  until  the  emer- 
gency arrives,  then  it  serves  only  the  pur- 
pose of  "locking  the  stable-door  after  the 
horse  is  stolen. ' '  If  put  out  in  anticipation 
of  the  emergency,  the  most  probable  effect 
is  to  postpone,  but  not  to  avert,  the  evil  day. 
All  such  measures  ignore  the  fact  that  the 
capacity  of  the  community  to  absorb  fresh 
supplies  of  capital  in  times  of  speculative 
excitement  and  extravagant  business  ven- 
tures is  absolutely  unlimited.  Moreover, 
they  fail  to  take  into  account  a  psychologi- 
cal factor  that  should  be  reckoned  with. 
Though  the  bankers  in  the  United  States 
are  generally  hard-headed  men  of  affairs, 
they  are  nevertheless  in  some  respects  as 
timid  as  young  gazelles.  That  is  one  of 
the  consequences  of  the  dangers  to  which 
our  banking  system  exposes  them.  Such 
is  their  dread  that  their  depositors  may 
become  alarmed  and  endeavor  to  transfer 
their  funds  to  safety-deposit  boxes,  that 
when  clouds  appear  upon  the  financial 
horizon  their  fear  of  seeming  to  be  afraid 
is  commonly  greater  than  their  fear  of 
the  impending  storm.  Any  bank  issuing 
emergency  notes  in  advance  of  its  fellows 
would  be  hoisting  a  danger  signal  not 

23 


unlikely  to  precipitate  a  ' '  run '  '  by  its  de- 
positors. The  fact  of  such  issue  might  be 
concealed  for  a  time,  but  not  for  very  long. 
If,  in  the  mean  time,  similar  issues  have 
become  general,  then  they  may  have  helped 
to  abate  to  some  extent  the  eagerness  of 
borrowers  and  the  alarm  of  depositors,  but 
if  insufficient  in  amount  to  allay  the  strin- 
gency, then  little  real  benefit  has  resulted. 
And  in  any  case  a  violent  check  to  busi- 
ness is  most  probable. 

In  this  connection  it  may  be  said  that 
a  truly  elastic  currency,  responsive  at  all 
times  to  the  needs  of  the  commerce  of  the 
country,  and  automatically  adjusting  itself 
to  these  needs  from  day  to  day,  is  greatly 
to  be  desired ;  but,  let  it  be  clearly  under- 
stood, as  an  every-day  affair  and  not  merely 
as  an  emergency  measure.  Between  such 
a  currency  and  a  bond-secured  issue  kept 
in  circulation  as  long  as  the  issuing  banks 
elect,  there  is  a  whole  world  of  difference. 
In  one  case  daily  redemption  in  all  the  lead- 
ing cities  compels  the  issuing  banks  to  be 
prepared  to  meet  their  notes  on  presenta- 
tion, and  however  they  strive  to  keep  them 
outstanding,  the  adjustment  to  the  needs  of 
the  people  as  a  whole  is  automatic ;  where- 
as, in  the  other  case,  the  redemption  ma- 
chinery being,  as  at  present  in  the  United 
States,  a  farcical  shadow  of  the  real  thing, 
the  volume  in  circulation  is  determined 
24 


only  by  the  cupidity  or  the  necessities  of 
the  issuing  banks.  The  issue  of  circulat- 
ing notes,  automatically  elastic  in  volume, 
begets  conservative  banking:  the  issue  of 
circulating  notes,  however  secured,  that 
may  be  kept  out  at  the  pleasure  of  the 
issuer,  tends  to  unwise  inflation  of  credit, 
and  necessarily  involves  the  danger  of  that 
effect. 

Recent  discussion  of  the  currency  ques- 
tion makes  it  evident  that  the  term  4 '  elas- 
tic currency "  is  not  widely  understood. 
One  banker  who  has  read  many  papers  op- 
posing the  idea  of  asset  currency  has  repeat- 
edly stated  that  in  his  opinion  the  elasticity 
would  be  chiefly  in  the  way  of  expansion, 
and  this  opinion  does  not  appear  to  have 
been  openly  challenged  in  any  of  the  gath- 
erings of  bankers  that  he  has  addressed. 
It  may  not,  therefore,  be  supefluous  to 
point  out  that  in  order  to  be  truly  elastic  in 
the  sense  in  which  the  term  is  used  by  the 
advocates  of  asset  currency,  the  adjust- 
ment must  take  place  daily  as  the  result  of 
a  contest  in  which  each  bank  endeavors  to 
make  as  wide  a  field  as  possible  for  its  own 
circulation,  by  presenting  for  payment  all 
notes  of  other  banks  coming  into  its  pos- 
session. Thus  it  becomes  impossible  for 
any  bank  to  keep  more  of  its  notes  in  cir- 
culation than  the  people  have  use  for,  and 
while  expansion  of  the  volume  outstanding 

25 


will  be  a  normal  experience  during  the 
autumn,  contraction  will  be  equally  certain 
at  other  seasons.  If  necessary,  every  bank 
issuing  such  currency  should  be  prohibited 
by  law  from  paying  out  the  notes  of  other 
banks;  but  self-interest  should  make  such 
a  law  needless. 

When  a  thoroughly  sound  and  scientific 
banking  system  is  established  in  the  United 
States,  such  an  elastic  currency  will  be  one 
of  its  important  features.  In  time  of  stress 
it  will  furnish  an  efficient  "safety-valve." 
At  all  times  it  will  operate  to  equalize  inter- 
est rates,  and  through  free  redemption  and 
cancellation  when  business  is  slack,  will 
tend  to  prevent  the  accumulation  of  the 
large  amounts  of  loanable  funds  that  are 
now  such  a  menace  to  our  stability. 

For  its  economical  working  such  a  cur- 
rency implies  branch  banking.  It  also  im- 
plies, for  the  protection  of  the  public,  that 
the  issuing  banks  should  have  large  capital, 
be  subject  to  stringent  regulations  in  the 
interest  of  sound  banking,  with  adequate 
penalties  for  their  infringment,  —  and  that 
government  inspection  should  be  of  search- 
ing thoroughness.  True  elasticity  could 
readily  be  imparted  to  our  present  national 
bank  currency  by  establishing  daily  re- 
demption in  all  of  the  reserve  cities,  com- 
pelling every  bank  having  notes  in  circula- 
tion to  maintain  a  redemption  agent  in  each 
26 


of  these  cities,  and  forbidding  the  banks 
to  pay  out  the  notes  of  other  banks,  but  in- 
stead, requiring  them  to  present  such  notes 
for  payment  just  as  they  present  checks 
drawn  upon  those  banks.  In  this  way,  and 
in  this  way  only,  can  elasticity  be  achieved. 
But  elasticity  would  make  a  bond-secured 
currency  unprofitable.  Even  with  the  full 
volume  outstanding  throughout  the  entire 
year,  the  increment  to  the  issuing  banks  in 
our  present  national  banking  system  is  very 
small ;  and  as  banks  are  not  eleemosynary 
institutions,  some  profit  to  them  must  be 
reckoned  upon  in  any  system  they  are 
expected  to  maintain. 

Desirable  as  is  a  properly  constituted 
elastic  asset  currency,  it  needs  to  be  said 
most  emphatically  that  to  authorize  the 
national  banks,  as  at  present  constituted,  to 
issue  unsecured  circulating  notes  would 
in  all  probability  invite  consequences  appal- 
ling to  contemplate.  Aside  from  the  unwis- 
dom of  allowing  a  multitude  of  small  banks 
to  emit  unsecured  circulation,  the  current 
practice,  to  which  reference  has  been  made 
in  this  paper,  of  the  virtual  pooling  of  re- 
serves and  the  investment  of  the  major  part 
of  these  reserves  in  loans  on  the  New  York 
Stock  Exchange,  is  alone  a  sufficient  argu- 
ment against  it.  But  another  and  more 
serious  objection  lies  in  the  fact  that  the  bills 
receivable  held  by  the  banks  in  the  United 
27 


States  are  not  liquid  assets.  Herein  lies  the 
vital  difference  between  banking  practice  in 
Europe  and  America.  And  this  difference 
points  clearly  and  unmistakably  to  the  nature 
of  the  change  in  our  method  of  making 
loans,  which  must  be  accomplished  if  we 
are  ever  to  have  a  scientific  banking 
system,  and  be  even  measurably  free  from 
the  violent  disturbances  and  distressing 
conditions  to  which  we  are  now  periodi- 
cally subject. 

A  business  man  of  high  standing  and 
wide  commercial  experience  told  the  writer 
not  long  ago  that  when  he  accepted  the 
position  of  director  of  an  important  bank, 
it  was  with  something  of  a  shock  that  he 
discovered,  as  he  did  very  soon  after  tak- 
ing his  seat  as  a  member  of  the  board,  that 
with  the  exception  of  "  paper  "  bought  from 
note  brokers  not  more  than  fifteen  per 
cent  of  the  notes  in  the  bank's  portfolios 
could  be  relied  upon  to  be  paid  when  due. 
The  relations  existing  between  the  bank 
and  its  clients  were  such  as  practically  to 
compel  the  granting  of  renewals  if  request- 
ed. This  is  not  an  isolated  experience. 
It  is  substantially  true  of  nearly  every  bank 
in  the  country.  Moreover,  many  of  the 
larger  borrowers,  who  under  ordinary  cir- 
cumstances place  their  paper  through  note 
brokers,  customarily  fall  back  upon  their 
banks  and  expect  to  be  taken  care  of  very 
28 


liberally  when  the  money  market  tightens 
and  the  brokers  are  unable  to  sell  their  pa- 
per. Demands  of  this  sort  must  be  met 
by  the  banks  under  penalty  of  the  loss  of 
valuable  business,  and  met  in  general  at  a 
moderate  rate  of  interest,  thus  prevent- 
ing them  from  reaping  a  harvest  at  the 
high  current  rate,  and  not  infrequently 
compelling  them  to  become  borrowers  in 
order  to  grant  the  accommodation. 

From  these  disabilities  and  disadvan- 
tages the  European  banks  are  exempt.  It 
is  not  their  custom  to  discount  the  simple 
promissory  notes  of  their  clients,  and  then, 
having  held  these  notes  until  maturity, 
to  take  in  satisfaction  of  them  similar 
notes  made  by  the  same  parties.  The 
practice,  so  common  in  the  United  States 
as  to  be  almost  the  general  rule,  for 
banks  to  furnish  their  clients  with  what 
amounts  to  fixed  capital  through  a  series 
of  renewals  running,  it  may  be,  for  years, 
would  be  regarded  as  the  height  of  bad 
banking,  and  absolutely  indefensible  from 
any  point  of  view.  The  legitimate  function 
of  banks  is  to  lend  temporary  capital  in 
the  shape  of  credit,  not  to  enter  into  quasi- 
partnerships  in  which  either  the  capital  of 
the  banks  or  the  funds  intrusted  to  their 
custody  are  embarked  in  manufacturing, 
merchandizing,  farming,  warehousing,  or  in 
any  other  business  enterprise,  taking  all 


the  risks  of  the  business,  but  gaining 
only  ordinary  interest  in  return.  To 
assert  that  it  is  only  temporary  capital 
that  the  banks  lend,  when  they  habitually 
grant  renewal  after  renewal,  and  that,  if 
they  have  used  good  judgment  in  making 
the  loans,  they  can  always  require  payment 
at  maturity,  is  merely  to  beg  the  question. 
Every  banker  in  the  United  States  knows 
that  in  the  majority  of  instances  there  are 
circumstances  that  would  make  such  a 
course  inexpedient  if  not  impracticable; 
and  in  time  of  stress  the  burden  of  "car- 
rying" the  clients  with  whom  such  rela- 
tions have  been  established  is  usually 
imperative. 

The  European  method  of  making  loans 
is  in  every  way  better  and  safer,  and  is  in 
strict  conformity  with  sound  banking  prin- 
ciples. It  is  not  only  safer  for  the  lenders, 
but  the  borrowers,  considered  en  masse, 
are  served  far  better  and  more  equitably 
than  they  are  with  us.  This  difference  in 
the  method  of  making  loans  is  the  fun- 
damental difference  between  banking  in 
Europe  and  in  the  United  States.  It  goes 
to  the  very  root  of  all  the  questions  involved 
in  the  reformation  and  modernizing  of  our 
banking  system  and  banking  practices. 
Even  the  currency  question  is  secondary 
to  it  and  is  largely  bound  up  in  it.  It  is 
not  because  they  have  elastic  currency  in 

30 


some  European  countries  that  Europe 
weathers  financial  crises  without  the  phe- 
nomena of  panics,  sudden  collapse  of  credit, 
loss  of  confidence,  violent  contraction  of 
the  volume  of  business,  and  all  the  attend- 
ant distressing  circumstances  that  we  know 
so  well.  The  real  reason  why  these  things 
are  avoided  is  that  the  bills  receivable,  which 
with  us  are  a  -fixed,  immovable  mass,  are 
with  the  European  banks  scarcely  less  liquid 
than  the  cash  in  their  vaults. 

Although  cash  advances  by  the  European 
banks  are  not  entirely  unknown,  they  are 
usually  for  small  amounts.  In  general, 
when  a  line  of  credit  is  granted,  it  means 
that  the  bank  agrees  to  accept  the  bills  of 
exchange  of  the  client  with  whom  the  ar- 
rangement is  made,  running  not  longer 
than  a  specified  time, — ninety  days  being 
the  usual  limit.  These  bills,  duly  accepted 
by  the  bank,  are  placed  with  a  bill  broker 
for  sale  in  the  open  market.  As  all  the 
European  banks  except  the  central  banks 
make  a  practice  of  accepting  such  paper, 
based  upon  collateral  security,  or  reliable 
guaranty,  or  thorough  knowledge  of  the 
financial  condition,  habits,  and  ability  of  the 
makers,  the  market  is  thus  supplied  with 
bills  of  the  highest  class.  To  some  extent 
the  standing  of  the  makers  influences  the 
rate  at  which  the  paper  sells,  but  in  general 
the  standing  of  the  accepting  bank  deter- 

31 


mines  its  salability,  and  the  question  of 
individual  credit  is  largely  eliminated. 
But  to  the  bank  the  preservation  of  its 
credit  is  of  vital  importance.  It  is  incum- 
bent that  sound  judgment  be  exercised  at 
all  times  in  accepting  bills.  The  amount  of 
paper  which  any  borrower  can  place  upon 
the  market  at  any  time  is  therefore  limited 
by  the  sum  which  his  bank  is  willing  to 
accept.  The  bank  on  its  part  cannot  pru- 
dently lend  its  credit  except  upon  the  con- 
dition that  its  client  does  not  enter  into 
similar  relations  with  any  other  bank. 
Furthermore,  it  is  customary  to  withdraw 
the  credit,  wholly  or  in  part,  whenever  it 
appears  that  the  financial  strength  of  the 
borrower  is  declining.1  Over-extension  of 
credit  is  thus,  for  the  most  part,  effectively 
checked,  and  the  whole  course  of  business 
made  safer  in  consequence. 

Such  is  the  character  of  the  paper  held 
by  the  European  banks.  There  are,  of 
course,  many  varieties  in  the  bills  them- 
selves, and  there,  as  here,  there  are  bills 
drawn  by  merchants  and  manufacturers 
upon  their  customers,  against  goods  sold. 
But  all  are  readily  marketable  at  any  time, 
and  no  stigma  attaches  to  a  bank  when  it 
sees  fit  to  dispose  of  any  part  of  its  holdings, 

1As  for  renewals,  it  is  usual  for  the  banks  to  re- 
quire that  maturing  acceptances  be  met  by  the  makers 
before  other  acceptances  are  given  in  their  place. 

32 


either  because  it  needs  cash  or  because  it 
can  reinvest  the  funds  to  advantage;  as,  for 
example,  by  selling  bills  that  are  about  to 
fall  due  and  buying  others  having  two  or 
three  months  to  run.  For  such  paper  the 
market  is  not  merely  local ;  it  is  as  wide  as 
the  whole  world.  It  is  the  rate  of  discount 
that  governs.  For  instance,  when  business 
is  active  in  England  and  the  open  market 
rate  in  London  is  higher  than  that  in  Paris, 
the  French  banks  buy  English  bills.  They 
may  not  know  much  about  the  makers,  but 
they  do  know  the  standing  of  the  accepting 
banks.  In  this  way  conditions  are  equal- 
ized for  borrowers  all  over  Europe.  To- 
day Austrian  bankers  may  be  investing  in 
Italian  paper;  six  months  hence  the  condi- 
tions may  be  reversed.  Only  the  United 
States  is  out  of  the  running,  having  no 
modern  bills  to  offer,  save  such  as  grow 
out  of  foreign  transactions,  and  which,  be- 
ing payable  abroad,  and  bearing  the  accept- 
ance 01  European  banks,  are  not  strictly 
in  point. 

It  will  be  observed  that  under  the  Euro- 
pean system  the  borrower  is  not  affected, 
as  in  the  United  States,  by  the  ability  or 
inability  of  his  bank  to  make  him  a  cash 
advance.  If  the  bank  feels  that  it  can 
prudently  lend  its  credit  by  accepting  his 
paper,  all  the  borrower  has  to  consider  is 
whether  he  can  sell  it  and  at  what  rate. 

33 


The  banks,  on  the  other  hand,  owe  their 
clients  nothing  that  need  cause  the  least 
embarrassment.  When  they  have  already 
loaned  all  that  they  should  loan,  they  are 
not  subject  to  being  called  upon,  as  our 
banks  are,  to  make  further  advances  that 
they  cannot  avoid  if  they  desire  to  retain 
the  business  of  the  applicant.  Moreover, 
they  have  no  relations  to  the  makers,  accep- 
tors, or  indorsers  of  the  bills  in  their  port- 
folios that  need  deter  them  from  reselling 
the  bills  at  any  time  they  may  desire,  either 
at  home  or  abroad.  And  should  they  find 
that  they  can  get  a  better  rate  by  adding 
their  indorsement,  no  loss  of  prestige 
thereby  ensues.  Far  otherwise  is  it  in 
the  United  States.  Our  banks  sometimes 
have  to  borrow,  but  all  sorts  of  shifts  are 
resorted  to  to  avoid  showing  rediscounts 
in  published  statements,  lest  they  be  inter- 
preted as  indicating  weakness. 

To  make  commercial  paper  always  a 
liquid  asset,  it  is  essential  that  the  market 
for  prime  bills  should  never  fail.  In  all 
the  countries  of  the  world  having  modern 
banking  systems  this  certain  market  is  in- 
sured through  the  medium  of  a  central 
bank.  The  primary  junction  o)  these  central 
banks  is  solely  to  provide  such  a  market.  The 
other  functions  that  they  may  perform, 
such,  for  instance,  as  the  handling  of  the 
government  funds,  and  the  issue  of  circu- 

34 


lating  notes,  are  merely  incidental,  and 
must  be  kept  so,  if  the  organization  is  upon 
a  right  basis.  The  usual  provision  by 
which  these  banks  are  kept  from  doing 
an  ordinary  commercial  business  is  their 
restriction,  in  buying  paper,  to  bills  bearing 
the  names,  as  acceptors  or  endorsers,  of  at 
least  two  banks  or  bankers  in  high  stand- 
ing. If,  in  addition  to  this  regulation,  the 
power  to  give  acceptances  be  denied,  the 
central  bank  becomes,  as  it  should  be, 
chiefly  a  bank  for  other  banks,  that  use  it 
to  rediscount  bankers'  acceptances,  with 
their  indorsement  added,  thus  bringing  the 
paper  within  the  requirement  that  it  must 
bear  the  names  of  two  banks  or  bankers. 
Through  the  power  to  issue  circulating 
notes,  the  ability  of  the  central  bank  to 
rediscount  for  them  is  made  sufficiently 
elastic  to  safeguard  all  emergencies. 

Of  all  these  central  banks  the  German 
Reichsbank  is  without  doubt  the  most  per- 
fect in  its  organization  and  the  most  effi- 
cient as  a  working  machine.  And  in  spite 
of  the  fact  that  a  part  of  its  stock  is  owned 
by  the  government,  it  demonstrates,  beyond 
cavil,  that  it  is  possible  to  keep  such  a  bank 
quite  free  from  political  influence.  The 
fact  is,  that  the  restriction  of  its  functions 
to  those  which  it  should  properly  perform 
removes 'all  reason  for  the  bank  being  "in 
politics. "  To  describe  in  detail  the  work- 

35 


ing  of  the  Reichsbank  or  any  other  of  the 
European  central  banks  would  unduly  ex- 
tend this  paper.  The  question  may,  how- 
ever, be  asked,  how  does  the  Reichsbank 
get  a  supply  of  bills  at  times  when  the 
money  market  is  easy?  The  answer  is, 
that  in  ordinary  times,  as  the  Reichsbank 
has  branches  in  all  the  important  towns  in 
Germany,  the  other  banks  find  it  a  most 
convenient  collection  agent.  The  custom 
is  to  rediscount  all  bills  payable  at  a  dis- 
tance. For  this  service  the  Reichsbank 
deducts  interest,  for  five  or  ten  days  accord- 
ing to  circumstances,  at  its  published  rate, 
which  is  usually  from  one  half  to  one  per 
cent  above  the  open  market  rate,  but  makes 
no  collection  or  exchange  charge.  As  the 
money  market  hardens,  bills  having  longer 
time  to  run  are  offered  for  rediscount,  and 
when  the  offerings  become  so  abundant 
that  the  bank  thinks  its  note  issues  need 
to  be  restricted,  a  check  is  interposed  by 
raising  the  published  rate  of  discount. 
This  published  rate  has  an  incidental  use 
of  great  value,  as  the  rates  allowed  or 
charged  upon  current  accounts  by  the  com- 
mercial banks  follow  its  fluctuations  and 
are  regulated  by  them.  For  such  a  regu- 
lator, it  may  be  said,  in  passing,  there  is  a 
crying  need  in  the  United  States. 

When   almost   all  of  the   banks'   assets 
are  liquid,  fixed  requirements  in  the  way 

36 


of  cash  reserves  are  obviously  needless. 
Nevertheless,  the  advantage  of  keeping  the 
volume  of  cash  in  the  country  in  due  pro- 
portion to  the  credit  fabric  erected  thereon 
is  also  obvious,  and  so,  when  loanable  cap- 
ital is  abundant  and  rates  of  interest  are 
low  in  any  country  having  a  modern  bank- 
ing system,  the  raising  of  the  published 
rate  affords  a  check  upon  the  tendency  of 
the  capital  to  find  employment  in  other 
lands,  with  gold  exports  as  a  consequence. 
Up  to  a  certain  point  such  exports  are  of 
no  importance,  and  efforts  to  prevent  them 
would  do  more  harm  than  good.  Beyond 
that  point  the  raising  of  the  rate  becomes 
effective.  Thus  does  a  central  bank  act 
as  a  regulator  in  more  ways  than  one. 
And  if  it  have,  as  it  should  have,  very  large 
powers  as  a  bank  of  issue,  it  should  also 
operate,  as  it  does  in  Germany,  to  prevent 
all  danger  of  a  money  squeeze  such  as 
we  in  the  United  States  experience  almost 
every  autumn. 

We  may  now,  it  would  seem,  address  our- 
selves with  some  clarity  of  vision  to  the 
solution  of  the  problem  of  what  should  be 
done  to  reform  our  unwieldy  and  unstable 
banking  system. 

The  chief  defects  of  the  system  may  be 
summarized  as: 

I.  That  the  assets  held  by  the  banks 
are  not  sufficiently  liquid. 

37 


2.  That    the     necessity    for     carrying 
balances  with  other   domestic    banks    for 
exchange    purposes   ties    up   too    large   a 
percentage  of  the  cash  resources  of  all  of 
the  banks, brings  about  the  artificial  multi- 
plication of  deposit  liabilities,  and,  through 
the  counting  of  these  balances  as  a  part  of 
the    required    legal    reserves,    results    in 
virtual  pooling  of  these  reserves  and  their 
investment  in  loans  upon  stock  exchange 
collateral,   thus  fostering  speculation   and 
inducing    recurrent    periods    of    financial 
distress. 

3.  That  when  these  periods  of  financial 
distress  come  about,  the  banks  are  com- 
pelled to  assume  a  hostile  attitude  toward 
each  other,   thus  greatly  aggravating  the 
distress. 

The  remedy  for  these  defects  is  to  adopt 
the  only  known  method  by  which  the 
assets  of  the  banks  can  be  made  liquid, 
and  by  which  the  necessity  for  carrying 
balances  with  other  domestic  banks  can  be 
avoided.  Briefly  stated,  it  implies  the  es- 
tablishment of  a  branch  banking  system,  for 
which  in  its  main  features  that  of  Canada 
may  well  be  taken  as  a  model,  and  also 
the  organization  of  a  central  bank  of  issue, 
closely  following  the  lines  of  the  German 
Reichsbank,  and  having  at  least  one  branch 
and  a  local  board  of  directors  in  every 
state  in  the  Union.  Whether  the  central 

38 


bank  should  have  a  monopoly  of  the  note- 
issuing  function  is  perhaps  open  to  ques- 
tion, but  in  the  opinion  of  the  writer  of 
this  paper  it  would  be  unwise  so  to  re- 
strict it.  One  important  reason  is,  that 
through  the  use  of  their  own  circulating 
notes  as  till  money  in  their  branch  offices, 
the  commercial  banks  would  be  enabled  to 
maintain  branches  in  smaller  places  than 
would  be  profitable  under  other  circum- 
stances. As  in  Germany,  the  profits  of 
the  central  bank  should  be  restricted ;  and 
other  details,  such  as  the  provision  that 
the  management  must  be  in  the  hands  of 
trained  bankers,  may  well  be  adopted. 

With  the  inauguration  of  this  system, 
the  organization  of  national  banks  under 
the  present  law  should  be  brought  to  an 
end,  and  all  the  banks,  old  as  well  as  new, 
should  be  required  to  provide  for  the  daily 
redemption  of  their  circulating  notes  in  all 
of  the  commercial  centers.  In  founding 
such  a  system,  great  care  should  be  taken 
to  avoid  introducing  features  that  would 
nullify  its  efficacy.  Only  banks  with  large 
capital  should  be  authorized  to  establish 
branches,  or  to  issue  unsecured  circulating 
notes.  Specific  authority  given  to  extend 
credit  by  accepting  time  bills  having  a  lim- 
ited time  to  run,  coupled  with  stringent 
restrictions  upon  the  power  of  the  banks  to 
invest  more  than  a  small  percentage  of 

39 


their  loans  in  paper  not  bearing  the  accept- 
ance or  endorsement  of  other  banks  or 
bankers,  should  —  and  doubtless  would  — 
suffice  to  introduce  the  European  method 
of  making  loans.  Once  introduced,  it  may 
be  depended  upon  to  take  care  of  itself  as 
against  any  other  form. 

So,  too,  with  branch  banking.  Under 
a  properly  organized  system  the  service 
would  be  far  more  efficient  than  anything 
the  people  of  the  United  States  have  ever 
known.  Not  only  would  there  be  a  larger 
volume  of  loanable  funds  from  the  same 
amount  of  resources,  but  these  loanable 
funds  would  be  equally  available  in  all 
parts  of  the  country  at  all  times.  The 
banks  would  be  stronger  and  safer,  and  not 
being  tied  together  by  depositing  their  re- 
serves with  one  another,  they  would  in  fact 
be  independent.  At  the  same  time,  being 
comparatively  few  in  number,  there  would 
be  more  possibility  of  concerted  action  in 
time  of  need  than  can  ever  be  hoped  for 
under  our  present  system. 

Against  branch  banking  it  is  often  urged 
that  borrowers  in  the  smaller  places  in 
Canada  do  not  fare  as  well  as  if  they  were 
served  by  independent  local  institutions. 
This  criticism  is  not  well  founded;  though, 
as  Mr.  Herbert  B.  Walker,  manager  of  the 
Canadian  Bank  of  Commerce,  Montreal, 
says  in  a  letter  to  the  writer,  "It  is  prob- 
40 


able  that  instances  could  be  cited  that 
would  seem  to  substantiate  the  statement 
that  the  smaller  towns  do  not  always  obtain 
all  the  borrowing  facilities  to  which  they 
imagine  themselves  entitled/'  Pertinent 
also  are  Mr.  Walker's  further  remarks. 
He  says:  "It  is  one  of  the  advantages  of 
the  branch  system  that  we  are  able  to 
gather  deposits  in  the  quiet  and  unenter- 
prising localities,  and  lend  the  money  in 
the  more  active  and  enterprising  places; 
in  effect,  therefore,  it  is  not  necessary  to 
have  an  equilibrium  of  deposits  and  loans 
at  each  branch  in  order  to  conduct  a  profit- 
able banking  business.  As  an  illustration 
of  this,  we  have  a  number  of  branches 
where  the  deposits  are  in  excess  of  the 
loans,  and  also  many  other  branches  where 
the  loans  are  greater  in  amount  than  the 
deposits.  In  the  main,  this  distribution  of 
capital  is  effected  with  the  best  of  results 
to  the  country  at  large.  I  am  not  pre- 
pared to  say  that  it  always  works  perfectly 
and  without  in  any  case  causing  injustice  to 
some  borrowers  whose  claims  for  banking 
credit  might  possibly  receive  more  favor- 
able attention  from  a  local  institution,  the 
directors  and  management  of  which  would 
have  a  greater  personal  knowledge  of  and 
interest  in  the  applicant  for  credit.  These 
cases,  however,  are  of  slight  importance  as 
weighed  against  the  fact  that  the  smaller 

41 


towns  and  cities  are  provided  with  bank- 
ing facilities  of  a  high  order,  such  as  few 
of  them  could  possibly  have  if  they  were 
obliged  to  depend  upon  the  sort  of  local 
banking  concerns  that  would  spring  up 
with  insufficient  capital  and  inexperienced 
management.  As  it  is,  there  is  keen  com- 
petition for  country  business  by  the  char- 
tered banks,  and  each  local  manager  is 
anxious  to  make  as  good  a  showing  as 
possible  for  his  branch,  and  is,  therefore, 
not  likely  to  slight  the  claims  of  his  own 
customers  for  accommodation." 

Naturally,  the  possible  introduction  of 
branch  banking  is  regarded  with  dismay 
by  many  bankers  throughout  the  country, 
through  fear  of  its  effect  upon  their  per- 
sonal fortunes.  It  cannot  be  doubted  that 
in  competition  with  well-equipped  branch 
banks  many  of  the  existing  institutions 
would  find  it  unprofitable  to  continue  in 
business.  But  the  change  would  not  take 
place  overnight.  Normally,  it  may  be  ex- 
pected to  be  a  slow  process,  a  gradual 
evolution,  requiring  many  years  for  its  ac- 
complishment. Here  and  there  an  inde- 
pendent institution  would  maintain  itself, 
as  the  experience  of  Canada  and  other  coun- 
tries proves.  But  also  it  cannot  be  doubt- 
ed that  the  bankers  of  the  United  States 
would  soon  perceive  the  clear  advantage  to 
themselves  of  amalgamating  their  separate 
42 


institutions  into  larger  ones,  branch  offices 
taking  the  place  of  unrelated  establish- 
ments, and  that  in  the  end  they  would  be 
gainers,  and  not  losers,  by  the  change. 

Under  such  a  scientific  system  as  is 
proposed,  the  changes  in  current  banking 
practices  would  in  many  respects  be  little 
less  than  revolutionary.  Many  of  the  ills 
the  bankers  now  combat  with  only  indiffer- 
ent success  would  be  things  of  the  past. 
For  instance,  the  competition  of  the  note 
brokers,  of  which  many  of  our  metropolitan 
bankers  have  just  reason  to  complain,  would 
be  quite  at  an  end.  Under  the  revised 
system  the  bill  broker  would  be  not  the  rival 
but  the  indispensable  adjunct  of  the  banks. 
The  vicious  practice  of  carrying  unsecured 
loans  along  from  year  to  year  would  become 
only  a  memory.  Lines  of  credit  would  be 
granted  only  after  full  and  careful  consid- 
eration, and  not,  as  too  often  at  present, 
upon  nothing  more  substantial  than  brief 
oral  statements.  The  granting  of  credit 
to  and  the  acceptance  of  paper  made  by 
firms  or  corporations  in  which  the  officers 
of  the  bank  are  interested  should  be  prohib- 
ited; but  even  if  not  forbidden  by  statute, 
the  effect  upon  the  credit  of  the  bank  in  the 
open  market,  as  reflected  by  the  discount 
rate  for  paper  bearing  its  acceptance,  would 
soon  operate  to  reduce  the  practice  to  very 
moderate  limits. 

43 


OF   THE 

UNIVERSITY 


In  addition  to  the  normal  check  upon  the 
present  tendency  of  the  surplus  capital  of 
the  country  to  gravitate  to  the  New  York 
Stock  Exchange,  which  a  scientific  system 
would  afford,  only  a  definitely  limited  pro- 
portion of  any  bank's  total  loans  should  be 
permitted  to  rest  upon  the  pledge  of  stocks 
or  bonds.  In  the  case  of  the  central  bank, 
it  should  be  provided  that,  as  in  the  case 
of  the  Reichsbank,  all  loans  upon  collateral 
should  be  made  at  one  per  cent  above  the 
published  discount  rate,  with  strict  limita- 
tions as  to  the  kind  of  collateral  acceptable 
and  the  percentage  of  the  market  price 
that  may  be  advanced.  The  reason  for  this 
is,  that  the  central  bank  should  not  ordina- 
rily make  loans  upon  collateral,  but  only  in 
times  of  emergency  when  it  might  be  desir- 
able for  the  public  good  that  it  should  be 
permitted  to  do  so.  The  primary  function 
of  the  bank  being  to  insure  the  liquidity  of 
the  bills  discounted  by  the  commercial 
banks,  its  loaning  power  should  in  general 
be  scrupulously  reserved  to  that  end. 

That  the  present  Sub-Treasury  system 
should  be  abolished  and  the  central  bank 
should  be  constituted  the  fiscal  agent  of  the 
United  States  and  made  the  depositary  of 
its  funds,  excepting  only  the  reserve  against 
the  legal-tender  notes  and  the  coin  repre- 
sented by  the  gold  certificates  and  silver 
certificates,  is  highly  desirable,  but  not  an 

44 


essential  feature  of  the  proposed  scheme. 
It  is,  however,  essential  that  the  central 
bank  should  be  effectively  divorced  from 
political  interference  and  political  power. 
It  is  not  necessary  that  the  government 
should  own  all  or  any  part  of  the  stock, 1  or 
that  it  should  exercise  any  supervision 
or  regulation  other  than  to  see  that  in  the 
conduct  of  its  affairs  the  mandates  of  the 
Bank  Act  should  be  strictly  obeyed.  In 
this  connection  the  writer  would  suggest  that 
the  Comptroller  of  the  Currency  or  the 
Superintendent  of  the  Banks,  as  he  might 
more  appropriately  be  designated,  should 
be  given  authority  summarily  to  remove 
from  office  any  bank  officer  within  his 
jurisdiction  whom  he  might  find  violating 
the  provisions  of  the  bank  act,  and  it  should 
be  his  duty  to  make  such  removal  upon  a 
proper  showing  of  culpability,  the  official 
so  removed  having  the  right  of  appeal  to  a 
trial  board  or  court,  which,  however,  should 
have  power  to  reinstate  him  only  upon 
clear  showing  that  he  had  not  been  guilty 
of  any  infraction  of  the  law.  To  make 
technical  compliance  with  the  statutory 
provisions  more  certain,  any  bank  officer  so 
deposed  should  be  disqualified  from  hold- 
though  not  necessary,  still  for  the  sake  of  the 
prestige  it  would  give,  government  ownership  of  a 
part  of  the  stock,  not,  however,  exceeding  one  fourth 
of  the  whole,  is,  in  the  opinion  of  the  writer  of  this 
paper,  highly  desirable. 

45 


ing  any  official  position  in  any  other  national 
bank,  and  be  personally  liable  for  any 
loss  caused  by  his  misconduct.  This  may 
sound  severe;  but  if  restrictions  upon 
banking  practices  are  demanded  in  the 
interest  of  the  public  welfare,  the  punish- 
ment of  those  who  offend  cannot  be  made 
too  drastic. 

To  prevent  the  control  of  the  central 
bank  falling  into  the  hands  of  any  one  man, 
or  small  group  of  men,  it  should  be  pro- 
vided that  no  one  person  should  hold  more 
than  say  one-twentieth  of  the  entire  capi- 
tal stock,  also  that  no  certificates  of  stock 
should  issue,  but  instead  that  the  ownership, 
which  should  vest  absolutely  in  the  nominal 
owner,  should  be  registered  upon  books 
always  open  to  public  inspection  at  the 
head  office  of  the  bank,  and  hypothecation 
should  be  specifically  prohibited, — the  pur- 
pose of  these  provisions,  which  might  well 
apply  to  the  stock  of  all  of  the  national 
banks,  being  to  prevent  men  from  holding 
shares  in  names  other  than  their  own,  and 
to  obviate  the  possibility  of  borrowing 
upon  the  stock  of  one  bank  to  secure  funds 
to  buy  up  a  controlling  interest  in  another. 
But  whether  such  a  provision  be  incorpo- 
rated in  the  bank  act  or  not,  there  can  be  no 
doubt  that  national  banks  should  be  prohib- 
ited from  loaning  upon  the  shares  of  other 
banks. 


With  the  establishment  of  such  a  system 
as  is  here  outlined,  the  bankers  of  the 
United  States  would  be  weaned  from  sev- 
eral infantile  notions  to  which  they  cling 
with  great  pertinacity.  One  of  these  is 
the  horror  with  which  they  contemplate  the 
acceptance  of  time  bills;  another  is  reluc- 
tance to  sell  unmatured  bills  receivable. 
It  is  true  that  under  the  present  law  the 
national  banks  may  not  incur  liability  as 
acceptor  or  endorser  save  to  an  extent  so 
limited  as  to  be  practically  prohibitive. 
It  is  also  true  that  there  is  now  neither  oc- 
casion for  the  acceptances  nor  a  market  for 
the  bills;  but  the  attitude  of  mind  goes 
farther  than  these  considerations,  and  the 
quicker  it  is  changed  to  a  more  cosmopoli- 
tan point  of  view  the  easier  will  it  be  to 
compass  the  reform  we  so  greatly  need. 

Another  of  these  crude  notions  is  the 
absurd  worship  of  deposits  that  our  present 
system  engenders.  Under  a  modern  sci- 
entific system  the  relative  value  of  deposits 
would  be  much  less  than  it  is  in  the  United 
States  at  present.  In  far  less  degree  than 
now  would  they  be  created  by  book  credits 
against  credit  loaned,  or  in  other  words, 
by  discounting  clients'  notes  and  adding 
the  proceeds  to  their  deposit  accounts. 
Perhaps,  also,  the  useful  distinction  be- 
tween "current  accounts"  and  "deposit 
accounts, ' '  commonly  made  in  other  coun- 

47 


tries,  would  come  into  vogue.  Cash  depos- 
ited in  one  bank  would  not  be  passed  along 
from  one  bank  to  another  until,  before 
reaching  its  final  resting-place  in  New  York, 
it  would,  as  is  now  often  the  case,  have 
swelled  the  deposits  of  three  or  four  banks. 
Banks'  balances  with  other  banks  would  be 
confined  to  the  accounts  of  the  few  inde- 
pendent local  institutions  that  might  sur- 
vive, and  would  be  limited  to  the  needs  of 
these  institutions  for  facilities  for  selling 
demand  exchange.  They  would  have  no 
object  in  keeping  large  balances  with  cor- 
respondents for  the  sake  of  interest,  since 
the  rates  would  always  be  regulated  by  the 
official  rate  of  the  central  bank,  and  the  idle 
funds  might  with  equal  availability  and  more 
profit  be  invested  in  commercial  paper. 

Theoretically,  under  such  a  system  as  is 
proposed,  the  banks  should  not  be  required 
to  carry  any  fixed  reserve,  arbitrary  regula- 
tions in  that  regard  being  calculated  to 
hamper  the  smooth  working  of  the  system. 
Practically,  however,  some  minimum  should 
be  specified.  This  would  not  need  to  be 
more  than  fifteen  per  cent,  except  for  the 
central  bank.  Experience  shows  that  the 
percentage  of  cash  reserve  that  safety  pre- 
scribes is  far  higher  under  our  present 
halting  and  inflexible  system  than  under 
one  properly  constituted.  In  Canada  the 
banks  get  along  comfortably  and  safely  with 


a  fifteen  per  cent  reserve,  and  they  do  not 
have  the  advantage  of  a  central  bank  and 
of  having  their  portfolios  filled  with  modern 
accepted  bankers'  bills,  which  would  make 
their  position  far  more  secure. 

Only  the  more  salient  features  of  the 
proposed  system  can  be  considered  in  this 
paper.  All  of  the  details  would  require 
careful  thought  in  drafting  an  enabling  act. 
For  any  insurance  fund  to  protect  deposi- 
tors there  would  be  no  need.  A  provision 
in  the  Bank  Act  that  any  institution  having 
its  capital  impaired,  in  however  small  de- 
gree must  at  once  make  good  the  deficiency 
or  close  up  its  affairs  and  retire  from  the 
field,  would  be  sufficient.  Granting,  how- 
ever, for  the  sake  of  argument,  the  neces- 
sity for  or  the  desirability  of  such  guaranty, 
then  to  be  equitable  the  banks  as  a  whole 
should  be  given  autocratic  and  plenary 
powers  to  supervise  and  regulate  the  busi- 
ness and  practices  of  their  fellows;  they 
should  not  be  charged  with  responsibility 
without  at  the  same  time  being  clothed 
with  authority. 

It  remains  to  be  said  that  to  graft  a 
central  bank  upon  our  national  bank  system 
as  it  is  now  would  be  the  height  of  folly. 
There  is  no  place  in  the  system  for  such  a 
bank,  no  function  that  it  can  safely  or 
properly  perform.  Desirable  as  is  such 
a  bank  in  a  sound,  well-considered,  and 

49 


thoroughly  scientific  system,  it  would  be 
worse  than  useless  as  an  adjunct  to  the 
nondescript  system  under  which  we  are 
working. 

To  the  establishment  of  the  better  order 
of  things,  ignorance  and  supposed  self-in- 
terest are  the  chief  obstacles.  Let  us  hope 
the  day  is  not  far  distant  when  they  will  be 
overcome.  One  difficulty,  however,  arises 
from  the  division  of  our  nation  into  sepa- 
rate states,  each  with  its  own  code  of  laws. 
To  work  effectively,  a  central  bank  should 
not  be  hampered  by  usury  statutes.  The 
effect  of  the  establishment  of  a  system  of 
branch  banks,  and  a  great  central  bank  as 
here  outlined,  would  almost  certainly  be  to 
lower  the  average  rates  of  interest,  and  to 
equalize  them  throughout  the  country.  But 
in  time  of  stress  the  central  bank  should 
have  power  to  mark  up  its  published  rate  as 
high  as  might  be  necessary.  Restrictions 
upon  the  rates  that  may  be  charged  by  pawn- 
brokers and  others  making  advances  upon 
chattels  may  perhaps  be  justified,  but  in 
business  transactions  incalculable  harm 
may  result,  as  every  bank  knows. 

So  utterly  futile  are  usury  statutes  to  ac- 
complish the  end  aimed  at,  that  it  passes 
comprehension  that  belief  in  their  efficiency 
should  still  persist  and  find  expression  in 
statutory  enactments.  In  New  York  the 
prohibition  of  time  loans  at  a  rate  above 


six  per  cent  compels  borrowers  to  have 
recourse  to  the  "call  money "  market, 
which  in  time  of  urgent  demand  is  some- 
times bid  up  to  ruinous  figures,  and  even 
.after  paying  the  high  rate,  the  borrower  is 
liable  to  be  required  to  meet  the  obligation 
at  an  hour's  notice.  Only  those  familiar 
with  the  effects  upon  the  New  York  money 
market  can  have  any  conception  of  the 
wide-spread  damage  that  results  from  the 
restriction  upon  interest  rates  imposed  by 
the  state  law.  Unless  the  law  should  be 
repealed  in  the  event  of  a  central  bank 
being  established,  that  institution  would  be 
shorn  of  a  large  measure  of  its  utility. 
As  the  only  object  it  could  have  in  raising 
its  published  rate  would  be  the  protection 
of  the  nation's  reserve  stock  of  gold,  it 
would  be  a  pity  if  this  resource  should  be 
denied  through  the  persistence  of  an  un- 
sound and  antiquated  notion. 

Since  we  must  eat  and  drink,  and  must 
supply  ourselves  with  clothing  and  shelter, 
we  may  defy  all  the  principles  of  finance 
and  still  continue  to  exist;  we  may  even,  in 
a  country  so  liberally  endowed  by  nature  as 
is  this  land  of  ours,  manage  %3  endure  the 
shocks  and  losses  which  such  defiance  en- 
tails, and  by  ravishing  the  natural  resources 
of  the  land  bring  prosperity  intermittently  to 
our  doors:  nevertheless  the  defiance  is  crass 
stupidity,  for  which  we  pay  a  heavy  price. 


We  may  struggle  along  for  generations  yet 
with  our  wretched  apology  for  a  banking 
system;  but  when  at  last  we  supplant  it  by 
a  system  based  upon  scientific  principles, 
we  shall  all  be  amazed  that  we  were  so  long 
in  seeing  the  light. 


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••'•*? 


NOV   6    1947 


• 


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02554 


